Treasury tips slow-down in growth rate

By BRIAN FALLOW economics editor

The economy is in for a period of below-average growth over the next 18 months or so, say Treasury forecasts in the Budget.

They estimate growth for the year to March to have been 3.3 per cent, a touch below the average for the past 10 years.

But they expect that to drop to 2.8 per cent by March next year and to 2.5 per cent the following year before recovering to 3.4 per cent in the year to March 2007.

That is slightly more than the most recent consensus forecasts compiled by the Institute of Economic Research.

These were for 2.7 per cent in the next 12 months and 2.2 per cent the year after, but they are two months old and do not reflect most of the recent fall in the exchange rate.

Consensus forecasts have been too conservative in four of the past five years.

On the other hand forecasters tend to over-estimate growth during slow periods.

The Treasury's growth track is a much gentler slowing than the hard landing some forecasters were picking earlier in the year, and because its forecasts were finalised a month ago they capture only some of the dollar's recent depreciation.

Slowing migration, slower employment growth and the delayed effect of the high exchange rate are the main reasons for the forecast drop in growth.

But growth is expected to pick up again from around the start of 2006 as the effect of the currency's fall comes through and a strong world economy boosts exports.

Among the assumptions behind these forecasts is that oil prices would decline from the US$32 a barrel they were at when the forecasts were finalised towards their long-term average of US$19.

Instead, oil prices have risen. If they climbed to US$40 a barrel, household discretionary income would be cut by about 0.2 per cent, the Treasury estimates.

Petrol would rise by 6c or 7c a litre, lifting inflation by 0.2 per cent.

But the inflationary effect could be greater than that if firms passed on higher transport costs to their customers.

The strong growth of the past couple of years was propelled by more jobs, higher wages and the "wealth effect" of soaring house prices, which encourage people to borrow and spend on the strength of increases in the value of their homes.

Over the next 18 months that effect is expected to wane.

The net inflow of migrants, a driving force in the housing market, peaked a year ago.

The Treasury expects the net annual flow of migrants to keep declining, but relatively slowly, from around 24,000 now to 15,000 by this time next year and 10,000 by June 2006.

The strong growth period has pulled the unemployment rate down to 4.3 per cent and pushed capacity use by manufacturers and builders to a 30-year high.

This has put upward pressure on inflation, which will now be compounded by more expensive imports as a result of the fall in the dollar's value and the rise in world oil prices.

But the Treasury expects the Reserve Bank to make only one more increase in interest rates, which would restore the official cash rate to a neutral level, neither stimulatory nor contractionary.

Capacity constraints have also encouraged businesses to make more investment.

This grew 12.1 per cent last year, the strongest growth since 1996.

The slowdown may be mitigated by fiscal stimulus, estimated to be of the order of 0.5 per cent of GDP in both 2006 and 2007.

"The steady growth of Government spending and the boost to household incomes from the For Families package provide a buffer to growth in this period of slowdown," it says.

But it expects employment growth to moderate, dropping below 2 per cent by the end of this year, for the first time since 1999, and to get even softer next year.

The unemployment rate rises to 5 per cent by the second half of next year.